It certainly is true that a rising stock market, over a long period of time, is a good thing.
But does that mean it is always a good development if the stock market has a big jump in one day? Or is it unambiguously bad news if there’s a significant one-day drop in financial markets?
I’ve been pondering this issue because recent stock market gyrations have triggered predictable finger pointing by politicians and pundits. Indeed, the past few days have been somewhat similar to the blame game that took place during the TARP bailout fight. Republicans and Democrats often have the same message: Any upward blip in markets is because “my side” did something good and any fall is because “your side” did something bad.
But so what? I certainly don’t pretend to be anything other than a policy wonk, so maybe people with real experience in financial markets can tell me that I’m way off base, but here are a couple of reasons why a short-term jump in the stock market might be a sign of bad news.
1. What if the Federal Reserve suddenly reveals that it intends to pursue an aggressive, easy-money policy? One likely result of such an announcement is that investors will pull money out of bonds, because of an expectation in the short run of lower interest rates (and therefore lower returns), and put that money into stocks.
Would that rising stock market be a sign of good economic policy, or would it just be a result of portfolio shifting, probably followed by weaker economic performance?
2. What if the Treasury Department announces that it will pay every underwater mortgage in the country. I wouldn’t be surprised if that was followed by a big jump in the stock market, led by financial companies such as banks.
Would that jump in stocks be a sign of good economic policy, or would it simply measure the value of a one-time wealth transfer from taxpayers to bank shareholders, probably followed by weaker economic performance?
My gut instinct is that these are examples of bad economic policies leading to short-term jumps in stocks. And this is why I try to avoid predicting markets when being interviewed.
But, if nothing else, I try to unleash a good one-liner during every interview. Here are two recent appearances, where I mention the “Sword of Damocles of big government” and “another Keynesian who’s been rattling around the revolving door of Washington and Wall Street.”